In the United States the House of Representatives passed the Senate’s budget bill to avert the so called fiscal cliff. The legislation avoids most of the tax hikes and spending cuts that threatened to tip the US into recession and the potential flow on that could have slowed the global economy. This will cut the fiscal drag for the US economy from a previously scheduled US$ 670 billion or 4.3% of GDP to around US$ 250 billion or 1.5% of Gross Domestic Product (GDP). This will constrain US economic growth during the next six months, particularly as a payroll tax hike will still take effect. However, a fiscal drag of 1.5%-2.0% of GDP is not enough to tip the US economy back into recession.
The US Federal Reserve (Fed) expanded its quantitative easing (QE) program by US$ 45 billion. The Fed will now buy US$ 85 billion US Treasury bonds each month. The Fed will continue this QE program until the US labour market notably improves. The Fed pledged its interest rate guidance will remain between 0%-0.25% as long as unemployment is above 6.5% and inflation below 2.5%.
The American consumer confidence trend improved. Data in the month showed US nominal retail sales improved in November, with a +0.3% month-on-month rise. There were strong rises in auto sales (+1.4% mom) and electronics (+2.5% mom). Building material sales rose by +1.6% mom, largely given the impact of Hurricane Sandy. In the past year, US retail sales have risen by a solid +3.7%. American housing also showed further encouraging signs of a solid recovery.
In Europe, concerns surrounding European sovereign debt continued to recede. Greece secured a crucial debt deal in the month that means the Greek government can now receive a new tranche of funding from the International Monetary Fund (IMF) and the European Union. Finance ministers agreed to the start of a banking union with the European Central Bank (ECB) as the common regulator by 2014.
Standard and Poor’s upgraded Greece’s sovereign rating from selective default to B- which saw its bond yields continue to fall and a further fall in Italian and Spanish bond yields. The swing from a downgrade to an upgrade cycle for Greece’s credit rating, the country which has been at the centre of the Euro-zone crisis, is very significant.
Europe’s PMI manufacturing surveys showed further signs of stabilising in December. While the European Commission (EC) surveys of business and consumer sentiment remain weak and bank lending is still contracting, this is consistent with a mild recession in Europe. However, a concern is Europe’s labour markets, which continued to deteriorate. Data in December saw the 14th consecutive monthly increase in unemployment across the Euro-zone. The unemployment rate is 11.7%.
China’s official manufacturing PMI (50.6) was unchanged in the month. This provided evidence that China’s economic slowdown is being successfully managed by policy makers as a number above 50 signals expansion. The index rise was led by a strengthening in new orders. This underpinned a continued improvement in overall output. In contrast, export orders declined sharply, given weaker demand from Europe. Given this, the stabilisation in China’s growth rate appears largely due to improved domestic demand, especially in the household and government sectors.
China’s industrial profits increased +0.5% in first 10 months of 2012 when compared with the same period in 2011. This suggests the downward trend in industrial profits is stabilising in line with signs of stability in the overall economy.
In Australia, the Federal Government dropped its surplus commitment. Maintaining the surplus would have required very aggressive fiscal tightening early in the new year which could have hurt the economy. The budget deficit will likely be around A$10 billion for this financial year. This is well below last year’s A$44 billion and is less than 1% of GDP. This is far smaller than most other comparable countries. As FitchRatings pointed out, the likely peak in Australia’s gross public debt at around 28% of GDP next year will still be below the median level of 52% for AAA rated countries. The outlook for Australia’s public finances remains in very good shape.
In Australia, an interview by Reserve Bank of Australia (RBA) Governor Stevens signalled that the transition from the mining boom to other sources of economic growth may not be seamless. This implied a bias toward lower interest rates.
International stock markets rose in December particularly given improved sentiment favouring a resolution of the outcome of the United States budget debate. Economic data in China suggested the economy is stabilising. This helped Asia Pacific share markets outperform in the month. The leading measure of global share market performance, the MSCI World (ex-Australia) Accumulation Index, rose 1.9% in local currencies (or 2.3% in unhedged Australian dollar terms). The US S&P 500 Accumulation Index returned 0.9% in local currency terms. In the European region, the Eurostoxx Accumulation Index returned +2.4% while the UK FTSE 100 Accumulation Index returned +0.6%, both in local currency terms. Asian share markets outperformed in the month with Japan’s Topix Accumulation Index returning +10.1%, while China’s S&P/CITIC 300 Total Return Index returned +17.5% in local currency terms.
The Australian share market delivered a good return of 3.3% in December. The cyclical sectors outperformed, partially due to improved sentiment surrounding the outcome of the US Fiscal Cliff and partially due economic signals suggesting more stability in China’s economy. In the year, more defensive sectors such as Healthcare and Telecommunications have consistently outperformed more cyclical sectors, such as Materials. In the 12 month period Healthcare and Telecommunications have risen +47.5% and +42.1% respectively, while Materials have risen +2.7%. The shift in sentiment to favour more cyclical sectors in the month is largely influenced from improved sentiment surrounding China’s near term economic outlook. In the month, all sectors rose while the Industrial sector (+5.8%), Materials (+4.8%) and Utilities (+4.1%) outperformed.
Real estate investment trusts
The Australian real estate investment trust (A-REIT) market rose in December, with the S&P/ASX 200 Property Accumulation Index up 3.4%. The listed property market rose given relatively positive economic data and policy actions aimed at stimulating the economy, such as dropping the Federal Government budget surplus target and the Central Bank lowering the official cash rate by 0.25% to 3.0%. The lower cash rate saw investors favour the more reliable earning characteristics of listed property.
While property markets ended the year positively, leasing markets remain fairly subdued in December due to concerns surrounding domestic and international economic conditions. However, values have largely stabilised across the sector. Office leasing sub-sector market remained slow in the month. Businesses remain focused on cost savings and tenant enquiry for new space is patchy. Cost saving has helped the industrial sub-sector market record steady momentum. The Retail sub-sector was negatively impacted by the cautious Australian consumer as retail spending was flat on the latest October results.
Solid US and Chinese economic data with further monetary policy stimulus by the US Federal Reserve saw global government bond yields generally rise in December. Concerns over the potential US budget tightening (the fiscal cliff) initially saw global bond yields being bid in early December. However more encouraging activity data in the US and China saw bond yields start to rise. The US 10-year government bond yield rose by 14 basis points (bps) over the month from 1.62% to 1.76%. In the UK 10 year bond yields edged higher by 5 basis points to 1.83% while Japanese bond yields rose by 7 basis points to 0.79%. The significant exception to this rising trend to Global yields were German 10 year bond yield which actually fell by 7 basis points to 1.32%. This reflected Europe’s weak economic activity as well as concern with Italy’s forthcoming general election in early 2013.
Australian bonds and cash
The Reserve Bank of Australia (RBA) cut the official cash rate 0.25% to 3.0% in December. This was widely expected and triggered little market reaction. The RBA noted that they believed a rate cut was necessary to balance the downside risks to growth, with particular concerns around the coming peak in resources investment and the lack of alternative growth drivers. This saw Australian bond yields rise. Three-year government bonds opened December at 2.61% moving to an intra-month high of 2.81%, before ending the month at 2.67%. Australian 10-year government bond yields started the month at 3.08% and finished the month at 3.25% (with an intra-month high of 3.37%).
Bank bills fell in December. The Reserve Bank of Australia lowered the official cash interest rate by 0.25% to 3.0% with the aim of stimulating the economy. The RBA said global growth is forecast to be a little below average. In addition, the inflation rate in Australia is in line with the target rate and is not a barrier to further easing. The three-month bank bill opened the month at 3.17% and fell 10 basis points (bps) to 3.07%. The six-month bank bill opened at 3.21% and closed 13 bps lower at 3.08%.
In December, the Australian Dollar fell against most major currencies (as per the Trade Weighted Index). The TWI closed the month at 77.1 (down 0.13% from 77.2). While cuts in the official cash rate are negatives for the higher value of the Australian Dollar, growing quantitative easing in the US, improved global growth and buying by central bank seeking to diversify holdings are positives. This factors signal the outlook for the value of the Australian Dollar is messy. The Australian Dollar closed the month at US$1.0382 (down 0.16% from US$1.0399) and ¥89.7628 (up +4.3% from ¥86.0327).
Commentary provided by Dr Shane Oliver, Head of Investment Strategy & Chief Economist, AMP Capital Investors Limited (ABN 59 001 777 591) (AFSL 232497).